Obama has posed this question and seems to think we can. William Dudley the new president of the New York Federal Reserve thinks they can and should act to identify and prevent asset- price bubbles. I remain very skeptical.
The Federal Reserve was formed in1913 to bring stability to the financial system. Yet in its first test, responding to the Great Depression, its actions made the depression last longer than any previous recession. The Fed had problems controlling inflation from the 1960’s until Reagan and Paul Volcker painfully wrestled it under control in the early 1980s.
Should all bubbles be contained? Is gold in a bubble now? If it is should we be concerned? Or should we just let gold prices take its course as it eventually did in the 1980’s? Bubbles seem to be clear only in hindsight.
Is it possible for the Fed to be truly independent of politics? I doubt it. The recent housing bubble was largely caused by political pressure to make housing more affordable. President Clinton thought this was a more progressive approach than just building more government housing projects. While this idea had considerable merit the devil is in the details and the execution of the laudable goal was a great driver of the housing bubbles.
Fannie Mae was driven by political goals and Congress fought efforts to bring it under control, almost along distinct party lines.
We had bubbles before the Fed and we have had bubbles after its formation. They seem to be more drastic since the Fed was created. The market forces may have popped bubbles quicker without the intrusion of political objectives into the mix.
But can the Fed even foresee and manage bubbles? If they can why haven’t they before? Greenspan noted that growth in wealth creation and savings in foreign countries had a great influence in the last bubble and was largely outside the control of the Fed.
Governments try to fight the last battle, leaving them wholly unprepared for the next one. It is like trying to play a board game when the rules and the board surface constantly changing. That is just the nature of the market. Those who think this beast can be tamed assume that all of the unknowns are known when the unknown unknowns are the real problems. Government always thinks they can analyze the last problem well enough to prevent the next one and they are rarely correct.
Efforts to contain bubbles may create such stagnation that the true cost of such policies will be hidden. While we desire stability do we really want it at the expense of economic growth? If the government is so willing to engage in economically destructive behavior such as massive debts and intrusion into markets how can we truly expect them bring such discipline to our economy to ‘manage’ bubbles, especially given their role in creating them?
“Nobody wants sound money.” It requires a discipline that our leaders clearly have not shown before, and this administration certainly doesn’t seem to have any. Trying to segregate politics from the management of credit and the money supply may be another utopian dream that costs far more than anyone is willing to pay.